The last few days in the markets have been absolutely brutal due to the uncertainty surrounding the European debt woes and the downgrade of the US from AAA. Fear is running rampant among many investors, leading to a massive selloff as money is hastily moved to cash and gold (which recently hit another record high of $1,700 an ounce). This creates a golden opportunity for anyone not swayed by the (admittedly substantial) decline in the market. A friend remarked to me over the weekend “I’m really worried about my investments; they are losing so much money!” This attitude is what drives selloffs – investors want to limit their losses before its too late.
Understandable? Yes. Logical? No. The crucial factor that many seem to be forgetting is that these losses are unrealized until the investment is actually sold. For instance, my shares of URG have dropped over 20% from last Thursday’s open, but I am not distressed in the least. Rather, I view this as an opportunity to increase my position in a company that I am very confident about for a bargain price. This allows me to lower the average price per-share of my investment, leading to greater gains in the future. This may be an odd concept to some, so let’s look at a relatively simple example using URG and some simple numbers:
Say I first initiated my position in URG with 1,000 shares at $1.50 a share, a total investment of $1,550. Then, because of the large price drop due to the current market conditions, I add another 1,000 shares at a price of $1.20. This brings my position in URG to 2,000 shares for $2,750. Now the average price per-share of my investment is $1.375, just over 8% less of the initial price I paid. Let’s say a year passes, and URG hits its price target of $4.50; I decide to sell all my shares. Had I not bought the additional shares, I would have sold 1,000 shares for a profit of $3.00 per share. On the other hand, closing the updated position nets me $3.125 per share.
This is a great strategy when you are very confident that a stock’s price is going to rally after a period of decline. All the same, you must have enough capital available to increase your position; otherwise it’s best to simply ride out the storm. The opportunity isn’t always right for some, but presents a wonderful chance for others to gain/profit.